Assuming the window for QE2 is slowly closing, it is time to begin thinking about what will happen to the economy and markets when QE2 ends. One of many aspects to this issue is how it will affect bond yields. I think conventional wisdom says yields should go up (and bond prices down) when QE2 ends since the dominant buyer of freshly minted bonds will be out of the market. Reinforcing that line of thinking would be the argument that the Fed would only end the bond buying program if the economy was improving, and an improving economy should put pressure on inflation and force bond yields higher. But we must always ask the question, what if the consensus is wrong? For example, perhaps the market focuses less on who is going to buy treasuries and more on the withdrawal of liquidity leading to less robust growth several quarters out. I’m not even sure how much of a surprise that should be given that at the start of QE2 conventional wisdom said that yields would go lower, and they did nothing but climb since the program was enacted on November 10th, 2010. Trying to anticipate what investors will be anticipating is one of the things investors must do, and it is one of the activities the investment team at Pinnacle Advisory Group is constantly engaged in. Rest assured that we’ll be thinking about the many aspects of an end to QE2 as we draw closer to June 30.
